1. CHAPTER 3
MEASUREMENT
OF COST
BEHAVIOUR

2. CHAPTER 3 LEARNING OBJECTIVES
Explain step- and mixed-cost behaviour.
Explain management influences on cost behaviour.

3. CHAPTER 3 LEARNING OBJECTIVES
Measure and mathematically express cost functions and use them to predict costs.
Describe the importance of activity analysis for measuring cost functions.

4. CHAPTER 3 LEARNING OBJECTIVES
Measure cost behaviour using the account analysis, high-low, visual-fit, and least-squares regression methods.

5. This chapter focuses on measurement of cost behaviour.
Introduction
This chapter focuses on measurement of cost behaviour.
WHAT DOES THAT MEAN?

6. Linear-Cost Behaviour
Linear-cost behaviour can be graphed with a straight line when a cost changes proportionately with changes in a single cost driver.

7. Progressive or digressive behaviour
Cost
Volume

8. Marginal cost (MC)
The extra cost for producing 1 unit more or
TC’(x)

9. Relevant Range
Recall that the relevant range specifies the limits of cost-driver activity within which a specific relationship between a cost and its cost driver will be valid.

10. Step- and Mixed-Cost Behaviour Patterns
Chapter 2 describes two patterns of cost behaviour:
variable and fixed costs.
Recall that a purely variable cost varies in proportion to the selected cost driver, while a purely fixed cost is not affected by the cost-driver level.

11. Step- and Mixed-Cost Behaviour Patterns
In addition to these pure versions of cost, two additional types of costs combine characteristics of both fixed- and variable-cost behaviour.These are
step costs and mixed costs.
See exhibit 3-2 page 88

12. Step Costs
Step costs change abruptly at intervals of activity because the resources and their costs come in indivisible chunks.

13. Capacity Costs
Capacity costs are the fixed costs of being able to achieve a desired level of production or to provide a desired level of service while maintaining product or service attributes, such as quality.

14. Mixed Costs
Mixed costs contain elements of both fixed- and variable-cost behaviour.

15. Committed Fixed Costs
Committed fixed costs usually arise from the possession of facilities, equipment, and a basic organization. These are large, indivisible chunks of cost that the organization is obliged to incur or usually would not consider avoiding.

16. Discretionary Fixed Costs
Discretionary fixed costs are costs fixed at certain levels only because management decided that these levels of cost should be incurred to meet the organization’s goals.

17. Discretionary Fixed Costs
Each planning period, management will determine how much to spend on discretionary items. These costs then become fixed until the next planning period.

18. Examples of Discretionary Fixed Costs
Advertising & promotion
Public relations
Research & development
Charitable donations
Employee training programs
Management consulting services

19. Cost Functions
The first step in estimating or predicting costs is cost measurement or measuring cost behaviour as a function of appropriate cost drivers.

20. Cost Functions
The second step is to use these cost measures to estimate future costs at expected, future levels of cost-driver activity.

21. Form of Cost Functions
An algebraic equation used by managers to describe the relationship between a cost and its cost driver(s) is called a cost function.

22. Cost Function Equation
Let: Y = Total cost
F = Fixed cost
V = Variable cost per unit
X = Cost-driver activity in number of units

23. Cost Function Equation
We can rewrite the
mixed-cost function as:
Y = F + VX
The mixed-cost function has the familiar form of a straight line -- it is called a linear-cost function.

24. Other examples Y = VX + F Y = AX2 + BX + F Y = AX3 + BX2 + CX + F
V1X + F1 for X<100
Y =
V2X + F2 for X>100

25. Plausibility
The cost function must be plausible or believable.

26. Activity Analysis
Activity analysis is especially important for measuring and predicting costs for which cost drivers are not obvious.

27. Cost Prediction
Cost prediction applies cost measures to expected future activity levels to forecast future costs.

28. Methods of Measuring Cost Functions
Once managers for a firm have determined the most plausible drivers behind different costs, they can choose from a broad selection of methods of approximating cost functions, including:

29. Methods of Measuring Cost Functions
Engineering analysis
Account analysis
High-low analysis
Visual-fit analysis
Simple least-squares regression, &
Multiple least-squares regression.

30. Engineering Analysis
Engineering analysis entails a systematic review of materials, supplies, labour, support services, and facilities needed for products and services.

31. Engineering Analysis
It measures cost behaviour according to what costs should be, not by what costs have been.

32. Account Analysis
The simplest method of account analysis selects a volume-related cost driver and classifies each account as a variable or fixed cost.

33. Account Analysis
The cost analyst then looks at each cost account balance and estimates either the variable cost per unit of cost-driver activity or the periodic fixed cost.

34. High-Low Analysis
A simple method for measuring a linear-cost function from past cost data is the high-low method. It focuses on the highest-activity and lowest-activity points and fitting a line through these two points.

35. Visual-Fit Analysis
In the visual-fit method the cost analyst visually fits a straight line through a plot of all of the available data, not just between the high point and the low point, making it more reliable than the high-low method.

36. Simple Least-Squares Regression
Least-squares regression (regression analysis) measures a cost function more objectively by using statistics to fit a cost function to all the data.